Ye Olde Gold Standard

One hears calls to return to “the gold standard” for currency periodically, but usually they arise during periods of high inflation and economic instability, not in times of strong, non-inflationary growth. The Presidential candidacy of Rep. Ron Paul, a staunch advocate of the gold standard, likely accounts for the most recent rumbling.

In addressing the question, we must first acknowledge that as far as assets to “back” a currency, gold stands alone. No other commodity even comes close. Gold’s intrinsic value has been recognized for millennia, across all cultures. It stands alone in stability of supply, too, with an estimated 99% of the gold ever mined still accounted for today (the rest having been lost to shipwreck or other disaster), and only 1-2% is added to the supply each year through new mining.

Gold has been well described as a “constant store of value.” In other words, over time your money is perfectly safe in gold: it will neither gain nor lose value. Generally, if the price of gold rises, it means the dollar is weaker; should gold fall, the dollar is gaining strength. Now, at first glance, it may seem odd that the price of such a stable commodity should be subject to speculatory binges, but it is simple economics. Because of the stable supply, increases in demand force the price up directly (as opposed to other objects of desire, where a rising demand and price would bring new supplies to market, no such thing happens with gold). Speculators rush to be the first on their block to buy gold at any sign of crisis or instability, secure in the knowledge the seekers of safety will follow and drive the price further.

As with all speculations, though, these bubbles eventually burst and gold returns to a more or less steady value. Even so, the variations in price of other commodities show far more volatility, leaving gold the best choice to back a currency.

Now, some of the advocates of a return to the gold standard promise outrageous benefits from the policy. They claim economic stability and growth unmatched, renewed confidence in the markets, and probably a cure for halitosis. History tells us otherwise, of course. We did have a gold standard for many decades, and under that standard we witnessed inflation, deflation, panics, recessions, booms and busts, and even the Great Depression. Gold hardly can claim to be a panacea for economic ills, based on experience.

The single question, though, proponents of a gold standard never seem able to answer is: Where does the gold come from?

The United States possesses the world’s largest gold reserves, roughly 25% of the world’s total supply. But even at today’s speculation-driven prices, the value of our reserves would not back even 40% of our currency in circulation. So, precisely WHERE would the balance come from?

Of course there is no reasonable answer. The ONLY way a gold standard could be implemented would be through a tremendous deflation, which would plunge not only the American economy, but the entire world’s into a depression of unprecedented depth.

The fact is that currency is a metaphor for wealth. Using gold to “back” currency provides a tangible metaphor, but it is still just a metaphor. Our wealth increases irrespective of how much our gold reserves increase or decrease, and our currency must reflect the current wealth. This is why we issued currency in excess of our gold reserves decades before Roosevelt outlawed the private ownership of gold specie. We had been on a “fractional gold standard” – meaning we held only enough gold to cover a fraction of the currency outstanding – for more than half a century before Nixon ended the charade.

But a “fractional” standard isn’t a “gold standard,” is it? Not if you are arguing that currency must be “backed” by specific amounts of gold in reserve, it isn’t. The truth is that our government, nor any other government, would never allow its gold reserves to be depleted by exchange for currency. No matter what.

The “gold standard” is a fantasy. It was a fantasy long before we abandoned it, and it remains a fantasy today. Get over it.